We Like These Underlying Return On Capital Trends At China Oilfield Services (HKG:2883)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, we've noticed some promising trends at China Oilfield Services (HKG:2883) so let's look a bit deeper.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for China Oilfield Services, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.058 = CN¥3.2b ÷ (CN¥75b - CN¥20b) (Based on the trailing twelve months to September 2022).

Therefore, China Oilfield Services has an ROCE of 5.8%. In absolute terms, that's a low return but it's around the Energy Services industry average of 7.0%.

Check out our latest analysis for China Oilfield Services

Above you can see how the current ROCE for China Oilfield Services compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering China Oilfield Services here for free.

What Does the ROCE Trend For China Oilfield Services Tell Us?

We're delighted to see that China Oilfield Services is reaping rewards from its investments and has now broken into profitability. The company now earns 5.8% on its capital, because five years ago it was incurring losses. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 26% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Key Takeaway

As discussed above, China Oilfield Services appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the stock has only returned 22% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So with that in mind, we think the stock deserves further research.

One more thing to note, we've identified 3 warning signs with China Oilfield Services and understanding them should be part of your investment process.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.